This article is authored by Urmil
Shah, a 3rd-year law student at AURO University, Surat
Introduction
There
has been quite deliberations on distributed ledger technology and its
application with smart contracts on utilizing it as a mode of dispute resolution,
from a conflict management standpoint. Although, smart contracts provide
endless potential to assist disputing management, particularly in the field of international arbitration due to its delocalized nature; however, the
compliance of such contracts with the domestic legal regime of states is
imperative to ascertain the validity, from legal certainty standpoint.
The article
analyses and compares smart contracts firstly, as traditional contracts to seek
domestic compliance with Indian contract law and secondly, as
arbitration agreement with the “soft” international arbitration regime. The
author attempts to establish that an effective sui generis legislation must be
passed for the domestic regulation of such contracts and their increased
compliance and utilization within most jurisdictions.
The convergence of technology and
law enhances the efficiency of conventional mechanisms of dispute settlement. The
emergence of technologies like distributed ledger technology (“DLT”)
provides a wide array of avenues for alternative modes of dispute
resolution. The prolific academic discourse on this theme has given the DLT a
novel dimension as a tool for enforcement of agreements without human
intervention.[i]
DLT, also referred to as block-chain, refers to a collection of blocks
(ledgers), linked through cryptography and distributed on an open-source. Some
of the most striking characteristics of block chain-like, decentralization,
flexibility[ii],
immutability, traceability of data, and reduced third-party intervention allows for the operation of highly confidential transactions in a secure manner[iii], changing the dynamics of interaction.
Block chain has a diverse application
as any transaction can be recorded on it; however, it is worth understanding
the deployment of Smart Contracts (hereinafter ‘SCs’) in the context of dispute
resolution. A SC is similar to a traditional agreement containing coded
instructions where the execution is automated. The essence lies in the fact
that it is neither smart nor a contract. They often operate on “if-then”
command. The terms are entered on the ledger (if-token-money-inserted-then-toffee-pops-out)
and the triggering event (inserting-token-money) occurs resulting in
self-execution of terms; however, once the transaction of inserting token money
is initiated it cannot be revoked and the entire transaction is carried out
without any human intervention. Such a revolutionary technology, when used on a large scale has the potential of removing intermediaries,[iv] thereby reducing transaction costs and
leading to the creation of an environment where the need for trust between
contracting parties is eliminated.
The potential of this technology can
be explored for the construction of the contract whereby obligations of parties are
entered on the ledger and at a particular date the enforcement of the agreement
is automated, leaving no hassle approaching courts for enforcement of the
contract.
However, the application of SCs
within the realm of DLT, to create and enforce contracts must seek compliance
with the domestic laws of the contracting parties. The author argues for the
positive compliance of SCs as traditional contracts within the contours of
Indian Contract Act, 1872 to operate as an arbitration agreement when the Lex loci arbitri is India and compliance with the NY Convention to operate as
an arbitration agreement in an international arbitration setup.
I. SMART CONTRACTS AS TRADITIONAL
CONTRACTS
The SCs often lie on a spectrum and have rarely operated in isolation. They are usually amalgamated with a variety
of hybrid agreements that pose numerous challenges to fundamental propositions
of the domestic contract law. As a general rule, in case of international
arbitration, the parties themselves determine the seat of arbitration,
subsequently, domestic law applicable to the parties is ascertained.
For an SC to be tested on the
touchstone of traditional contracts, the domestic contract law of the parties
has to be taken into consideration. For the purpose of regulatory analysis, the
Contract Act is taken as a benchmark for determining the compliance of SCs. The
ICA provides for certain fundamentals that distinguish a contract from a mere agreement, namely lawful consent, consideration, a lawful object, and competence of the parties. When dealing with SCs, there is a possibility that the consent of a
contracting party is obtained by way of misrepresentation or mistake, since the
terms of the contract are coded, making the understanding of obligations
cumbersome for them.
Moreover, the ICA doesn't deal with
e-contracts; however, common law principles are referred to interpret such
contracts. These contracts are signed through cryptographic hash key functions
which require compliance with the IT Act, 2000 to be used as a lawful form of
digital signature[v]
and with the Indian Evidence Act, 1872 to be used as a valid form of evidence
in Indian courts.
The electronic and automated nature
of SCs leaves a nagging space of conundrum where the lex loci is India
and Indian laws are made applicable. The recognition of such disruptive
technology requires a sui generis regulatory framework for their
operation as a valid form of contracts as was the case with the Uniform
Electronic Transactions Act.[vi]
II. SMART CONTRACTS AS AN
ARBITRATION AGREEMENT
The raison d'être of
international arbitration is its consensual and delocalized[vii] nature, which makes it an appropriate
platform to resolve disputes arising out of SCs. Article II of the NYC provides
a detailed understanding of the structure and fundamentals of an arbitration
agreement. It states that the agreement must be in writing, defined legal
relationship between contracting parties, which must concern an arbitrable
subject-matter with an undertaking to submit differences to arbitration. The “writing”
requirement complies when the agreement is signed by the parties;
however, NYC doesn't provide any guidance regarding the signature of parties.
The UNCITRAL ML on e-Commerce provides a substantially broad determination to a
signature where any method can be employed as long it identifies the person,
his approval to information, and is reliable for the purpose of such
information. The requirement is broad in its categorization but takes into
account several non-exhaustive factors like the sophistication of equipment,
kind of transaction, a function of signature, etc. to ascertain the intention
of parties.
Moreover, the definition of a data
message is also "not limited to” the methods provided under the
treaty, thereby increasing the scope of acceptance of hash keys.
Since the legitimacy of a contract
and an arbitration agreement is governed by the law of the seat of arbitration,
the requirement of a defined legal relationship may be difficult to determine
since very few jurisdictions consider SCs a valid form of contracting. The term
“arbitrability of the subject-matter” has often had different
interpretations[viii]
and is also to be determined by the law of the seat; however the UNCITRAL Model
Law doesn’t provide any guidance as to the arbitrability of disputes and the
Working Group’s view was that ML should not contain a provision delimiting
non-arbitrable issues[ix],
where often there is inconsistency among jurisdictions for a standardized
arbitrable subject matter.[x]
For instance, In A. Ayyasamy v.
A. Paramasivam, (2016) 10 SCC 386, it considered that disputes involving
insolvency and bankruptcy are non-arbitrable whereas the US Federal Rules of
Bankruptcy Procedure provides for arbitration as a viable model for dispute
resolution for insolvency and bankruptcy purposes.]
Although, the regulatory framework
pertaining to usage of SCs as an arbitration agreement is broad enough to
capture the technological peculiarity; the paradox lies in the fact these rules
also, refer to the law of the seat of arbitration. This creates a situation where, although the arbitration agreement has the capacity to significantly
alter the existing mode of dispute resolution; however, the regulatory
structure pertaining to SCs domestically represents a somber picture. SCs
provides a novel perspective of utilizing it as an efficient mode of ADR a
mechanism, replacing the existing modes involving courts and middlemen which
creates an environment of corruption and red-tape bureaucracy; however the
present the legal regime of most jurisdictions doesn’t provide for them as “valid
and legal” mode of dispute resolution.
CONCLUSION
The proliferation of DLT and SCs
have been primarily affected due to the “trustless” factor; however,
it's worth noting that the accuracy of SCs depends entirely upon the original
coding. The potential application of blockchain is countless ranging from
banking and finance, real estate, insurance, auditing, art, stock exchanges,
intellectual-property to almost all commercial transaction capable of being
recorded on a ledger. The most interesting of such application is when it is
used to form a legal and binding contract. Blockchain provides endless
opportunities for forming effective, creative, yet diverse agreements capable
of reducing inefficiencies existing within the enforcement of traditional
contracts. However, for proper implementation of such contracts within the purview of a regulatory regime, it must comply with domestic regulations. SCs have not developed for the potential where it can be utilized for resolving
disputes via arbitration in an automated manner; however, the prospective scope
has to be channelized to effect a regulated mechanism capable of dispute
settlement.
[iv] Scott
McKinney, Smart Contracts, Blockchain, and The Next Frontier of
Transactional Law, 13 WASH. J.L. TECH. & ARTS 313 (2018)
[v] The IT
Act is silent on the aspect of private and public hash keys as a valid form of
signature and merely provides for validity of digital e-signatures, refer,
Rishi A, The Legality of SCs in India, IndiaCorpLaw,
https://indiacorplaw.in/2017/12/legality-smart-contracts-india.html
[vi] Section 7
UETA provides for legal recognition to e-signatures, records, and contracts.
See, Alan Cohn, Smart After All: Blockchain, Smart Contracts, Parametric
Insurance, and Smart Energy Grids, 1 GEO. L. TECH. REV. 273 (2017).
[vii] Jan
Paulsson, Delocalisation of International Commercial Arbitration: When and
Why It Matters, 32 ICLQ 1 (1983).
[viii] Mahmood
Bagheri, International Contracts and National Economic Regulation: Dispute
Resolution through International Commercial Arbitration, Kluwer Law
International, 11 (2000).
[x] In Olympus
Superstructures v. Meena Khetan, 1999 (3) SC 514, the Supreme Court took
the view that only dispute arising of specific performance of the contract are
arbitrable.
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